This article was inspired by a recent Q&A I participated in on the topic of what most people overlook when planning for retirement. I provided my brief answer, but I feel that this issue is very important, so I wanted to expand on it and write an entire article.
What exactly is diversification? According to the Investopedia definition, it "is a risk management technique that mixes a wide variety of investments within a portfolio." The basic theory behind this concept is that a portfolio that includes a variety of different kinds of investments will typically yield better returns with lower risk, on average, compared to any single individual investment.
We find the concept of diversification present even in ancient times. Advice written in the book of Ecclesiastes more than two millennia ago said to "divide your investment among many places, for you do not know what risks might lie ahead.”
So, how can we apply it wisely today when investing for retirement? There are numerous opportunities to diversify, and real estate is one of the most popular investments because it offers higher return potential and lower risk due to the investment being secured. The IRS does allow alternative investments -- including real estate -- in an IRA, but to take advantage, you need a self-directed IRA or a truly self-directed Solo 401(k).
Deciding whether you want to take a more active role when investing your retirement account or a more passive role will help you to choose what alternative assets you should consider. Here are a few options in the real estate field that may be worth a closer look as you seek diversification in your own portfolio:
Real Estate Crowdfunding
One of the hottest trends in alternative investments right now is real estate crowdfunding. Real estate crowdfunding platforms allow you to invest either directly or indirectly in real estate investments presented through the platform by real estate investment sponsors. Your investment would be either in the equity of the property (with your returns coming from rental income) or in debt (with your returns coming in the form of interest on the loan). Many of these crowdfunding platforms do extensive vetting on the individual investments they make available.
Most real estate crowdfunding platforms require a minimum investment, making them a great starting point for the smaller investor and are a great way to keep your investments diversified. Returns can range widely -- for the highest returns, seek out equity investments. Some platforms do require you to be an “Accredited Investor” while others do not, so be sure to check for this if you are not accredited.
Real Estate Syndications
Another alternative option is to invest in a real estate syndication. This is a group real estate investment that allows you to passively invest in large real estate investments. These larger syndicated investments could include the purchase of an existing apartment complex, new construction of an apartment complex or home subdivision, or a commercial real estate project. The syndicated project can range from just a couple million dollars to tens of millions and have a typical investment horizon ranging from three to ten years.
Real estate syndications are offered by a sponsor who identifies the real estate opportunity then makes the investment and management decisions. The sponsor usually contributes some percentage of the capital needed. They may obtain institutional financing for a portion of the project and then pool the rest from the syndication investors, or they may raise the funds needed entirely from private investors.
To participate, you are usually required to be an accredited investor and minimum investments are typically higher than those required for real estate crowdfunding.
Turnkey Rental Properties
For those wanting to own individual properties in their retirement account or wanting to invest in residential rental properties, turnkey rentals may be the route for you. A turnkey rental could be a newly renovated existing home or new construction. Either way, the turnkey rental provider takes care of the renovations ahead of time, saving you the hassle of rehabbing. Further, property management and your first tenant are normally in place, making your investment more passive.
It is becoming increasingly popular to invest in out-of-state turnkey rentals, especially for those investors living on the west coast who want the higher returns that rentals on the east coast may provide.
With turnkey rentals, you have the ability to leverage and increase your ROI. Most turnkey properties can be purchased with 20% down and a good turnkey provider will have lenders they can refer you to.
Investing In Notes (Be The Bank)
The note (or Promissory Note) is a contract between two parties. The borrower agrees to repay the loan under agreed upon condition (set period of time, interest rate, penalties, etc.) to the other party (the lender or payee). There are secured and unsecured notes -- secured notes are backed by an asset, such as real estate (can be residential or commercial, first position or junior liens).
One of the advantages of investing in notes is increased liquidity. An investor can sell, recapitalize or even borrow against a note -- options that are rarely so easy in other real estate ventures.
Conclusion
Alternative investments are a great way to diversify your investments while earning higher returns and having some fun in real estate investing. Your keys to success will be learning to do your proper due-diligence and being sure to seek the advice of your own financial adviser, accountant or attorney regarding each investment.
